In a mythical American past, families took out one 30-year mortgage, worked at one company for 30 years while paying off the mortgage and sailed off into retirement free of debt.
Today, the reality is that the dream of retiring debt free is fading, and debt among older Americans is soaring. The percentage of households headed by someone aged 65 and older who held any debt increased to 61% in 2016 from 38% in 1989, according to the Federal Reserve—while real average debt increased to $86,797 from $29,918 (in 2016 dollars).
While it’s always been fashionable to advise old people to pay off their debts before retirement, for many people it’s just not realistic. And at the same time, paying down debt while in retirement can be extremely challenging, thanks to the vagaries of a fixed income.
Cost-of-living increases for Social Security have hovered around 2% for many years, so it’s not hard to see how cruel the math of a 19% credit card APR or even 8% student loan interest rate can be for retirees.
Here’s the truth: There are no easy answers when it comes to paying down debt in retirement. Let’s look at the upsides and some of the downsides of nine strategies that might help, depending on your particular circumstances.
1. Stop Digging the Debt Hole
It’s essential to stop racking up debt when you stop working. That might sound obvious, but it’s not always so clear for some retirees, says Paul Miller, a New York-based CPA.
“Many people think that when they retire, their expenses go down, but they tend to increase,” says Miller, owner of Miller & Company, LLP. Retirees want to do things that cost money, like travel. Some people buy a dream retirement home, when they should be downsizing, Miller says.
When you’re on a fixed income in retirement, take extra care not to add more debt. That’s especially true of high-interest debt, like credit card debt. If you hope to get free of what you owe, that means living well within your means so you have resources to pay down existing debt while eschewing more.
2. Don’t Try to Fix Mistakes with Bigger Mistakes
Some people end up in retirement and realize they haven’t saved nearly enough, then make rash decisions in an effort to make up for lost time. That can be catastrophic, Miller warns.
“People become day traders. They do things outside their normal personality… and they jeopardize their retirement,” Miller warns. He’s seen plenty of cases where one spouse doesn’t tell the other about these risky steps until things really go south. “And most often, it’s irreparable at that point,” he says.
If you haven’t saved enough for retirement, look for ways to maximize your available retirement funds. That could mean working longer to delay taking Social Security, which offers you larger monthly payments the longer you defer it, or…
3. Find an Extra Income Stream
Though it might seem obvious, establishing a new income stream is really the best answer for many who do not have enough retirement savings. Part-time work—as a consultant, as a gig worker, at a coffee shop—might not be your dream retirement scenario, but it’s really the least-bad choice of all the other options to deal with debt in retirement.
So let’s change that old axiom about paying off debt before retirement: Keep working, at least a little, when you have high-interest debt to pay.
An added benefit of stretching out your working life is you may be able to obtain health insurance to bridge the gap to Medicare age. You also give your existing retirement savings more time to compound and grow, which can help build your nest egg.
4. Consider Paying Off Debt with Retirement Funds
Leveraging your retirement savings to pay off debt can be tempting, but it’s also risky and must be done with great care, even if you’ve hit 59 ½ and can do so penalty free.
First, consider that you lose not only the cash you withdraw from investments, but also potential future market gains. Say you live to 85 and pull out $20,000 at age 65 to pay off a car loan. You’ve just lost 20 years of investment growth. If someone had made that move 20 years ago, in 2001, they would have given up an extra $58,000 in their retirement account today (assuming the money would have been left in an S&P 500 index fund).
But that’s not even the only reason to avoid using retirement funds for debt pay off. Consider interest rates. With fixed-rate debt—like some mortgages, for example—the face value of your payment remains consistent, even as inflation rises. This means the longer your mortgage term, the less real value you’re paying for it.
“There’s an incentive to keep the mortgage instead of committing other assets,” says Chris Chen, a certified financial planner (CFP) with Insight Financial Strategists.
In addition, you may cause unintended tax consequences for yourself. For starters, you could miss out on years of being able to deduct mortgage payments from your taxes. But you’ll also potentially incur a large tax bill if you’re taking money out of a traditional individual retirement account (IRA) or 401(k) account.
“Depending on the case, you could end up with 60 to 70 cents for every $1 withdrawn,” says Chen. “In this case, the retiree gives up an appreciating asset, pays taxes, in order to pay off a depreciating debt.”
Finally, if you’ve been paying off your debt for a while, keep in mind that you may not actually save that much in interest by paying your debt off now. If you are only a few years from paying off a loan, most of your payment goes towards principal, so the interest savings is minimal, Chen says.
5. Downsize, Especially If Home Prices Are Rising
If you own your home—or most of your home—consider scaling back on your house size and amenities, particularly if you are lucky enough to live in an area where housing prices have risen significantly.
Take that hard-earned equity and move into a smaller home that’s cheaper to maintain, and hopefully has more predictable repair costs and property taxes into the future. You may also choose to take your money and use it to buy a house in an area with a lower cost of living, if family circumstances allow.
“The problem is that a retiree may find it difficult to qualify for a mortgage. So, if there is equity in the house, that may well be the upper limit of a downsize,” Chen says.
6. Carefully Consider Home Equity Loans or Debt Consolidation Loans
Pooling some of your debts to get a lower interest rate can work in some special circumstances. This is especially true if you have untapped equity in your home and can use it for a low-interest home equity loan.
The trouble is this strategy includes all the risks of borrowing money to fix a spending problem. Depending on your particular situation, you may end up violating tip #2: Don’t try to fix mistakes with bigger mistakes.
Home equity loans or debt consolidation loans can make a lot of sense for a one-time surprise medical bills, for example. But if the underlying spending/income mismatch isn’t fixed, you’re just causing more debt headaches down the line.
7. Use a Reverse Mortgage to Pay Mortgage Debt
Another way to tap home equity without incurring another monthly debt payment is a reverse mortgage. This tool can be used by people aged 62 and over to borrow against their home equity, and payments aren’t required until the borrower sells the house, moves or dies.
If you’re not ready to give up ownership in your home, you might consider a reverse mortgage home equity line of credit, which makes that money available if you need it in case of emergency. Reverse mortgages have a checkered past, but new regulations have cleaned up the industry, to a degree. Still, proceed with caution.
“If their retirement plan is tight already, which is the case for many, a retiree can monetize their home by replacing their mortgage with a reverse mortgage,” says Chen. “The benefit is that they would free themselves from monthly payments without depleting their retirement assets.”
8. Cash Out Life Insurance Policies
You might have value in a life insurance policy you don’t really need any longer, such as if your kids are finished with college. You can access the money in a cash value policy by taking a loan against it or even surrendering the policy. This strategy can be expensive, however, with fees eating up as much as 30% of the settlement value. There can also be tricky tax complications, so proceed with care.
Note that you cannot pursue this strategy with term life policies, which are very popular because they are cheaper options. Getting cash value from life insurance only works with permanent life insurance such as whole life or universal life insurance.
In certain situations, you can also get money for a policy via a life settlement transaction. This strategy is mainly suitable for older policyholders who are in bad health.
8. Consider a Credit Card Balance Transfer
Transferring a credit card balance to a card with a lower rate—or a low intro rate—are two good ways to get out from under oppressive interest rates. But they come with one very large caveat: The tactic should really be a one-time tool.
Borrowing money to pay debts doesn’t solve the underlying problem. That’s why the best answer for older people with oppressive levels of debt is often…
9. Declare Bankruptcy
It’s okay to waive the white flag: Bankruptcy laws exist for a reason. Many older Americans have a strong ethos to pay all their bills, and that’s a good thing. But when you can’t pay, you can’t pay. And the sooner you come to that realization, the better.
Many people make huge mistakes while spiraling out of control, taking out home loans or spending retirement money to pay down debt that could be discharged in bankruptcy.
Social Security and many retirement accounts are protected assets in bankruptcy. That can make many older Americans “judgement proof”—they have no assets for a credit card issuer to claim. That also means it can be worth negotiating debt relief from certain kinds of loans without declaring bankruptcy, says Gerri Detweiler, author of “Debt Collection Answers.”
“If you do need to negotiate down the balance and don’t care about your credit history, you could potentially settle debt for substantially less than you owe,” she says. “Doing so will hurt your credit score, but do you really need good credit history any more?”
Bankruptcy shouldn’t be the first resort, but it shouldn’t be the last resort, either. Just beware that it doesn’t solve all debt problems. Student loan debt generally cannot be discharged in bankruptcy, though Miller suggests that clients in big trouble convert student loans to credit card debt, then discharge that later through bankruptcy.
Detweiler recommends finding a bankruptcy attorney via the National Association of Consumer Bankruptcy Attorneys.
Too Much Debt in Retirement? Make a Plan and Stick To It
When it comes to paying debt in retirement, older Americans should prioritize their own needs when choosing their strategy, says Miller.
“A lot of people have this, ‘I want to leave this for my kids’ mentality,’” says Miller, who recommends that your first priority is to take care of your own finances.
If you’re retired and feeling overwhelmed by debt, pay for the services of a financial planner or CPA who can help you make a plan to clean up your financial life. Most importantly, follow their advice and stick to the plan.
